The government on Monday defended the Reserve Bank of India’s decision to mandate banks to maintain 100% cash reserve ratio (CRR) on incremental deposits between September 16 and November 11, saying it was aimed at curbing likely capital outflows after excess liquidity brought down yields of government securities.

To assuage concerns in the market that these deposits would virtually earn nothing, economic affairs secretary Shaktikanta Das said the government would shortly seek Parliament nod to issue more securities under the market stabilisation scheme to compensate banks for absorbing the excess liquidity.

On November 26, the RBI announced that scheduled commercial banks would have to maintain an incremental CRR of 100% on the increase in deposits during the above period, the move was termed drastic by analysts. On Monday, bank stocks fell up to 3%.

CRR hike became necessary due to increase in liquidity in the system as large sums of money in the form of scrapped R500/R1,000 notes was being deposited by the public in banks since November 10. CRR is the portion of the deposits which banks are required to park with RBI. “Increase in CRR is a part of the liquidity management strategy used by RBI. Perhaps it has become necessary in the context of excess liquidity in the system. As you know excess liquidity adds to the volatility in the currency market,” Das said.

He said RBI has already given a proposal for increasing the Market Stabilisation Scheme (MSS) limit and “it is under the consideration of the government”. MSS, a tool used to manage liquidity, was earlier fixed at R30,000 crore for FY17.

“The imposition of this drastic control measure is because adequate collateral of government securities is not available at RBI window and hence this step of impounding all excess reserves at zero interest cost to RBI,” said economists at SBI.

Das said one thing “to be noted” was that bond yields and G-Sec rates in India were going down unlike all other emerging markets. “It is merely happening because of excessive liquidity that we have in the system. When bond yields go down naturally there is tendency on part of the people to take money out into high yielding areas,” Das said. Therefore, its impact was also being felt in the currency market and some quantum of outflow of FII and other investments could not have been ruled out, he added.